A company which is growing from strength to strength each year except in the all important bottom-line segment
ACC Limited continues to hasten slowly along the beaten path-selling the same product that it has been making since its inception more than seven decades ago. Sticking to the knittings has been its mantra all along. Cement is its mainstay and given the generic positioning of the product on offer, it does not necessarily follow that profits will be chasing the growth in revenues as one cannot put a price premium on the product on offer. It is the plain vanilla stuff that is on offer. The price follows the dictates of the market. No such luck. On the contrary, the 10 year summary of its financials reveals a topsy turvy story.
In almost every year in the last one decade-2003-04 to 2012-- the company ponied up a steady growth in revenues each year over that of the preceding year. Its net sales grew from Rs32.8 bn in 2003-04 to Rs 111.30 bn in 2012. The production figures over the decade are not available-but still. (There was a change in the accounting year from March to December in the interim). That’s the good news. But the earnings before interest, depreciation, and taxes (EBIDTA) and the profit before tax (PBT) tell a totally different tale. The figures on display weave a very erratic but understandable pattern. For the matter of record the company recorded the highest EBIDTA and PBT for the decade in 2009.
Rock solid balance sheet
The point is also that the company has a rock solid balance sheet. The net worth (share capital plus reserves) grew each year while the borrowings (or debt) fell each year to touch a low of Rs 1.6 bn in 2012 from Rs 13.5 bn at the beginning of the decade. The interest that it received on funds deployed was more than enough to take care of the interest that it had to pay out on its debt. It also boasted a jingling cash box of Rs 6.7 bn at year end, and liquid debt investments of the value of Rs 23.5bn-up from Rs 11.8 bn previously. It also gained some money here-Rs 847 m---by churning its portfolio of current investments during the year. It has also tossed over Rs 1.2 bn as advance to related parties-which appear to be of the gratis variety or some such. The dividend per share too has witnessed a rise each year over that of the preceding year-with the company forking out over 60% of its post tax profits as dividend in 2012. It generates the cash flow to make this possible. These figures per-se represent very favourable tailwinds and are not to be sniffed at
Where it could improve on in a manner of speaking is in the current liabilities to current assets ratio. Very successful market leaders - of which ACC is one such - normally try to present a year end picture of current liabilities in excess of current assets-Bajaj Auto will swear by it. This is supposed to be some sort of an extreme litmus test of your ultimate hold on the market. ACC has not quite got there as yet.
Cement companies however face several operational headwinds. There is always an excess of supply or an excess of demand. The industry can never get its act together in this respect and create the middle situation. Based on either scenario the open market price of cement yo yo’s up and down. Price cartels are not an effective offensive strategy anymore, due in part to the creation of the Competition Commission. (A foot note to the accounts states that the cement majors including ACC have been fined Rs 11.5 bn by the Commission on a complaint lodged by the Builders Association of India alleging anti-competitive practices. This fine has been challenged before the tribunal). The Competition Commission is becoming an effective watchdog-which should come as some sort of a revelation.
The other equally serious headwind is the inability to control input costs of materials consumed and on account of freight and forwarding expenses -which is a major head of expenditure. These are some of the more debilitating expense items on the expenditure list of the cement industry. Input cost of materials is still a small expenditure item in comparison to other larger cost items -- but still. Freight and forwarding expenses rose 18% against a 17.6% rise in net revenues while the cost of materials consumed rose 46.8%. (The company has got a hold on controlling the input costs of power and fuel which is another major head of expenditure). Bulk items like cement are basically transported by rail over long distances or by ship -- as road transport is definitely not an option here. Some cement companies have tried to get around the problem of coast to coast transport by buying dedicated ships but this leads to its own set of expenses. Another rising cost in the future could be royalty payments to the BIG BOSS. In 2012 the payments were restricted to Rs 1.30 bn against a larger Rs 1.38 bn previously. But this head of expenditure will up in the future.
There is another bugbear too. Cement units are highly capital intensive. Consider the following stats. In end 2012 the company boasted a gross block of Rs 101.5 bn and recorded revenues net of excise of Rs 113.5 bn. That works out to a gross block to revenue aggregate of 1:1.12. The ability to generate revenues is thus limited and with limitation comes a host of caveats. It is of course the company’s good fortune that good financial management implies there is no debt is incurred to finance gross block expansion. In 2012 for example it generated a cash flow of Rs 15.8 bn from operating activities and it purchased fixed assets including capital work in progress of Rs 5.7 bn. Capacity levels are not required to be furnished anymore, but the company adds that it produced 24.1 m tonnes of cement against 23.4 m tonnes previously. (The company intends to add another five million tonnes of cement manufacturing capacity by 2015 at a capital cost of Rs 33 bn). Funding this expenditure should be a piece of cake given its finances.
Brilliant inventory and cash flow management
The volume sale of cement kept pace with the production which would imply a very fine tuned inventory control management leading to a saving on working capital costs. It also makes and sells ready mix concrete but its contribution to the top-line is still fairly insignificant at Rs 6.1 bn. In any event it was unable to turn a profit on the sale of this item. The company lost a small bundle at the end of the day. It also sells more ready mix than it makes which implies that it also buys ready mix from the market for resale. The company rang up total net revenues of Rs 116.2 bn and a pre-tax profit of Rs 17.8 bn for the year against figures of Rs 98.5 bn and Rs 15.4 bn previously. Other income is only a bit player in determining its revenues and profits.
The company spins like a top that is for sure. This aspect is quite visible from the year end financials. It has reserves of Rs 71.9 bn against a paid up capital of Rs 1.87 bn. (The directors’ could definitely consider the issue of free shares given this anomaly). Minimal borrowings backed up by a surfeit of cash. The value of inventories at year end amounted to a mere 9% of gross revenues from operations while the company has mastered the art of selling its produce cash down. The trade receivables at year end were a pittance at Rs 3 bn and this figure is lower than the year end trade payables at Rs 6.6 bn. This in effect shows its hold on the market.
The cash flow statement too depicts the picture of a ship sailing with a very favourable tailwind. Not only are the funds generated sufficient to fund the capex on hand, the balance surplus funds were put to a two pronged effect. The cash and bank balances and the funds invested in debt schemes cumulatively moved up by Rs 2 bn.
It is indeed a pity that a company of such a stature cannot produce superior bottom lines at the end of the day.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme